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Financial Management

Higher Business Management

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Role ofFinance

Maintain financial records

Paymentofbills and expenses

Collection ofaccounts due Monitoring offunds

Paymentofwages and salaries

The main role Finance providesinformation for managers and decision-makers within business

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Annual

Acc

ounts

There are four main financialstatements used (called Final

Accounts):

Trading account

Profit and loss account Balance sheet

Cash flow statement

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Trading, Prof

it & Loss

Acc

ount

The trading account records how muchmoney is made from selling goods against

how much it costs to make. The gross profitis calculated in the trading account.

The profit and loss account shows thebusinesses incomes and expenditures. Thenet profit is calculated in the profit and lossaccount.

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Trading Account Format

Turnover (or sales) 180,000

Costof sales

Opening Stock 40,000 Purchases 95,000

135,000

Less: Closing Stock (45,000) 90,000 GROSS PROFIT 90,000

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Profit and Loss Account

Format Gross Profit 90,000

Other income

Interest received 11,000101,000

Expenses

Rent and rates 25,000

Wages and salaries 45,000

Insurance 2,000 72,000

NET PROFIT 29,000

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Profit and Loss Account Key

Terms Trading account provides summary of

businesss trading activity during financial year

Sales monies received through sellinggoods/services

Costof sales costof sales to a businessbefore a profit margin is added

Opening stock value of stock at startof thefinancial period

Closing stock value of stock at end of thefinancial period

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Purchases costofgoods business hasboughtfor resale to customers

Purchase returns value ofgoods purchasedbut returned to supplier

Sales returns value ofgoods bought bycustomer but returned to the firm

Expenses any expenses incurred by thebusiness in the course ofnormal operation

Profit and Loss Account Key

Terms

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Balance Sheet

The profit and loss account shows thehistory of the business activity

through

out the

financial year. The balance sheet shows a snapshotof

a particular date in time.

CAPITAL = ASSETS - LIABILITIES

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Balance Sheet

Assets Liabilities & Capital

Balance

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Assets

Assets are what a business owns

Fixed assets have a lifespan ofmorethan one year, eg machinery, motorvehicles

CurrentAssets are constantlychanging eg stock, debtors, bank, cash

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Liabilities

Liabilities what is owed by the business

Current Liabilities eg trade creditors(suppliers ofgoods on credit), bankoverdraft, short-term loans (less than 1year)

Long-term liabilities normally longer than1 year eg mortgage, bank loan

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Capital

Capital provided by the owner of thebusiness and treated as being owned to theowner of the business

Profits may increase capital

Drawings may decrease capital

Reserves monies retained by business

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Liquidity Liquidity shows us whether a business

has enough assets to cover its debts.

Turning assets into cash to pay offdebts is what normally happens.

Stock is the hardest to turn into cash.Why?

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Working Capital

Working Capital is:

CurrentAssets Current Liabilities

Ifa business has too much workingcapital then they are not using their

resources properly. If too little, then they may not be able

to pay off short term debts.

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Balance Sheet Format

Fixed Assets

CurrentAssets

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Recap

Balance Sheet

Assets

Liabilities

Capital

Liquidity Working Capital

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What areRati

os?

Ratios are a way of comparing differentfigures.

Rati

os sh

ould

only be used when c

omparinglike with like (ie same size ofbusiness; same

industry)

Ratios can compare results with previous

yearsor ri

val

firms Ratios, however are historic, and do not take

into accountofother factors such as qualityofworkers, inflation, economic situation

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Uses

ofRati

oA

nalysis Compare current performance with

previous years

Compare performance against similarorganisations

Identify changes in performance to aid

future actions

Identify trends over time

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Limitations

ofRati

oA

nalysis Information is historic

Comparisons mustonly be made with

similar organisations (size, industry) No accountofexternal factors (PEST)

No accountofNPD or declining

products No accountofhuman factors (staff

morale, staff turnover)

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Rati

os

Profitability

Gross Profitpercentage

Net Profit

percentage Return on Capital

Employed (ROCE)

Liquidity

CurrentRatio

Acid TestRatio

AssetUsage Rate ofStock

Turnover

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Gross Pr

ofit Percentage

Gross Profit

Sales Revenue

Measures profit made from buying andselling stock

For every 1 of sales, how much profit ismade?

Increase = more sales generated or costofmaterials have fallen

Decrease = costofmaterials may have wentup

X 100%

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Net Prof

it PercentageNet Profit

Sales Revenue

For every 1 of sales, how much profitafter expenses is made?

Increase = handling expenses better

Decrease = expenses may have wentup

X 100%

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Return on Capital Employed

(ROCE)Net Profit

Capital Employed

If you invest 100 in a firm how muchwill you get back?

ROCE should be measured againstinterest rates. Since your savings canmake money in a high interest bankaccount

X 100%

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CurrentRati

oCurrentRatio = CurrentAssets:Current Liabilities

Looks at how business can pay off its debts

A ratioof2:1 is considered prudent, but does nottake into account stock being held.

Higher than 2:1 means money may not being

invested in the business properly

Having less than 2:1 may mean the firm is indanger ofnot being able to pay offdebts (too much

money tied up in st

ock?)

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Acid Test

Rati

o

Acid Test =

Current assets stock: current liabilities

This is a tougher ratio than the current ratiobecause it excludes stock, since stock is thehardest asset to transform into cash.

This ratio should be around 1:1.

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Rate

ofSt

ock Turn

over

Stock turnover =CostofSales

Average Stock

Stock hanging around is bad for the firm. Stockscan gooff, outoffashion or outofdate.

This ratio works out how many times stock is used

up.

Note: Average Stock is calculated by adding Closing

and Opening Stock and then dividing by 2

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Cash Flow Statements

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Cash Budget

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Cash Flow Pr

oblems

Sources ofProblems Solution

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Users

ofFinancial In

formati

on

Shareholders can assess Boardsperformance and decide about

investment

or disin

vestment Potential Shareholders decide

whether firm is a worthwhile risk

Short term creditors should credit be

granted to the firm? Long term creditors should money be

lended to the firm? Will it be paid back?

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Users ofFinancial Information Government and local authorities look to

directors report and business plan. Do these plansaffect local area?

Competitors compare themselves with rivals to

work out market share and ifplans conflict withtheir own

Employees can the firm pay better wages? Isthe future sound?

Management use info to evaluate pastperformance and used to plan for future

Cust omers is firm likely to still be around? Otherconcerns, eg environment

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Sources

ofFinance

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Internal Sources

ofFinance

Retained Profits profit kept bycompany for future activities

Selling Assets money raised by sellingoffan asset no longer needed

Both are Short-term

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External Sources

ofFinance

Long Term (10 years +)

Issuing Shares capital raised byselling shares

Debentures a fixed interest long termloan

Loans borrowing money, repaid overa time period with interest

Mortgages a loan secured for property

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External Sources

ofFinance

Medium Term (1-10 years)

Leasing renting equipmentorpremises

Hire Purchase acquiring an assetoncreditfollowed by fixed payments. After

last instalment purchaser owns asset. Loans

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External Sources

ofFinance

Short Term (up to 1 year)

Overdraft borrowing more moneythan is available in bank account

Trade Credit businesses receive goodsfirst, then pay later

Factoring a specialist businesscollecting unpaid debts for a fee

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Additi

onal S

ources

ofFinance

LEC ScottishEnterprise

Renfrewshire Local authorities

EastRenfrewshireCouncil

GovernmentPartnerships Business Gateway

Grants andallowances

Repayable Grants,Soft Loans,Subsidies

EU grants

RegionalDevelopment Fund& Social Fund

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Budgets Budgets are statements ofanticipatedfuture expenditure covering a specific

time period

Cash Budgets show expected

receipts & paymentson a m

onthly basisto help assess potential cash flow

problems

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Uses

ofBudgets

To monitor & control

Gain information

To

set targets

To delegate authority

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How budgets help managers

Make them accountable for decisions

Help check income & expenditure

Can highlight need for corrective action

Help develop long term plans

Assists with decision making

Ameans of comparison with actualresults